If you’re considering buying a business, it’s important to understand how the related investigation and acquisition costs are treated for federal income tax purposes—especially if a deal falls through. A recent example illustrates how these rules work.
Jim, an employee looking to become a business owner, spent $15,000 researching an industry and identifying a target company. Once he decided to acquire that business, he incurred an additional $35,000 in legal, accounting, and similar fees. When the purchase failed, the tax consequences depended on the nature of each investigation and acquisition cost:
- Initial investigation costs ($15,000). Because Jim never acquired the target business, his early research and start-up expenses are treated as personal and non-deductible. However, if he later buys a business in the same field, he may roll some or all of the costs into the new start-up and treat them as amortizable start-up costs.
- Acquisition-specific costs ($35,000). Professional fees incurred after Jim committed to the purchase must be capitalized. Since the deal collapsed within a year, he may treat these costs as a short-term capital loss, deductible against capital gains and up to $3,000 per year of ordinary income until fully used.
Bottom line. A failed acquisition can still produce valuable tax benefits. Start-up and transaction costs are handled differently, and proper classification helps ensure you capture all available deductions and losses.
If you want to discuss investigation and acquisition expenses, contact us today!